Did you get burned during the dot com bubble? Did you lose a bunch on online pet food stocks? What about the real estate and credit market implosion? Did you get burned there too? Many people did. Many only had a strategy based on markets going up forever. We all know how that turned out. Does everyone lose at bad times? No. There are winners. They are the trend followers. They are not the mutual fund owners. First piece of education? If you own mutual funds...sell them all tomorrow!
My work (and my Trend Following book) is the result of a 14-year "hazardous journey" for the truth about trend following trading. It fills a void in a marketplace inundated with information about buying low and selling high, index investing, and all other types of fundamental analysis, but lacking any resource or, for that matter, practically any reference to what I believe is the single best strategy to consistently make money in the markets. That strategy is known as 'trend following'.
One author described it succinctly: "Let's break down the term 'trend following' into its components. The first part is 'trend.' Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, then you will not be able to sell at higher prices ... 'following' is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then 'follow' it."
Trend following trading seeks to capture the majority of a market trend, up or down, for profit. It aims for profits in all major asset classes•stocks, bonds, currencies, and commodities. Unfortunately, however simple the basic concepts about trend following are, they have been widely misunderstood by the public. My desire to correct this state of affairs is what, in part, launched my research. I wanted to be as objective as possible, so I based my writing on all available data:
• Trend followers' month-by-month performance histories
• Trend followers' published words and comments over the last 30 years
• News accounts of financial disasters
• News accounts of the losers in those financial disasters
• Charts of markets traded by trend followers
• Charts of markets traded by losers in the financial disasters
If I could have written a book comprising only numbers, charts, and graphs of trend following performance data, I would have. However, without any explanation, few readers would have appreciated the ramifications of what the data alone showed. Therefore, my approach to writing 'Trend Following' became similar to the one Jim Collins describes in his book 'Good to Great', in which a team of researchers generated questions, accumulated data in their open-ended search for answers, and then energetically debated it.
However, unlike Collins who was writing about generally well known public companies, trend followers form a sort of underground network of relatively unknown traders who, except for an occasional article, the mainstream press has virtually ignored. What I have attempted to do is lift the veil, for the first time, on who these enormously successful traders are, how they trade, and what is to be learned from their approach to trading that we might all apply to our own portfolios.
'Trend Following' challenges much of the conventional wisdom about successful trading and traders. To avoid the influences of conventional wisdom, I was determined to avoid being influenced by institutionalized knowledge defined by Wall Street and was adamant about fighting "flat earth" thinking. During my research, starting with an assumption and then finding data to support it was avoided. Instead, questions were asked and then, objectively, doggedly, and slowly, answers were revealed.
If there was one factor that motivated me to work in this manner, it was simple curiosity. The more I uncovered about trend followers, the more I wanted to know. For example, one of the earliest questions (without an answer already) was learning who profited when Barings Bank collapsed. My research unearthed a connection between Barings Bank and trend follower John W. Henry (now the majority owner of the Boston Red Sox). Henry's track record generated new questions, such as, "How did he discover trend following in the first place?" and "Has his approach changed in any significant way in the past 30 years?"
I was also curious about who won the $1.9 billion hedge fund Long Term Capital Management lost during the summer of 1998. Why did the biggest banks on Wall Street invest $100 billion in an options pricing model with so much inherent risk? Further, considering what mutual fund and hedge fund managers lost during October 2008 and what successful trend followers earned during the same time, I could not understand why so few investors were oblivious to even the existence of trend following trading. Other questions quickly appeared:
• How do trend followers win in the zero-sum game of trading?
• Why has trend following been the most profitable style of trading?
• What is the philosophical framework of trend followers' success?
• What are the timeless principles of trend following trading?
• What are trend followers' worldview of market behavior?
• What are the reasons why trend following is enduring?
Many of the trend followers studied are reclusive and extremely low key. Some discovered trend following on their own and used it to make their fortunes out of home offices. Bill Dunn, a successful trend follower who has beaten the markets for over 30 years, works out of a quiet, Spartan office in a Florida coastal town. For Wall Street, this approach to trading is tantamount to sacrilege. It goes against all the customs, rituals, trappings, and myths we have grown accustomed to with Wall Street success. In fact, it is my hope that my profiles of trend followers will correct the public's misconception of a successful trader as a harried, intense workaholic who spends 24/7 in the labyrinth of a Wall Street trading firm, surrounded by monitors and screaming into a phone.
When the first edition of 'Trend Following' hit the streets in April 2004 I hoped to assemble the first comprehensive look at trend following trading. Almost five years since initial publication, that goal was realized. How did I know? Since the first edition of Trend Following, I have met literally dozens of trend following traders managing collectively billions upon billions of dollars. Their feedback has been the validation. I never would have expected that an obscure book put together five years ago would lead me to having conversations with the likes of Nobel Prize winner Harry Markowitz and hedge fund managers Boone Pickens and David Harding, but it did.
Validation aside, October and November 2008 (and now into 2010) made me want another bite at the apple, another chance to "work" on my book. And lucky for me, the 2008 market chaos gave me that window. There is no doubt that October and November 2008 were the most historic market months since the Great Depression. Most people, most mutual funds, and most hedge funds lost unimaginable sums of money. It has long been said that "genius is leverage in a rising market," and when the bubble popped in 2008 clearly people who had long been positioned as genius weren't that smart after all. Already guessed where I am headed with this rant? Yes, while the rest of the world got creamed in 2008, trend followers made fortunes. Performance numbers for top trend following traders for October 2008 alone ranged from +5 percent to +40 percent. Making that much in one month when much of the rest of the world was losing big time is noteworthy to say the least. My publisher Jim Boyd agreed with me.
My new edition of 'Trend Following' includes many new sections and insights, surrounding the same core timeless lessons from the first edition. I updated throughout and worked to make material accessible and interesting enough so it might give an occasional "aha" experience. However, if you're looking for trading "secrets," you need to look elsewhere. There is no such thing. If you're in the mood for stories about what it's like inside a typical Wall Street firm (at least in those firms before they all went under!) or how greedy traders sow the seeds of their own destruction, your needs will not be met with my writing. But if you are looking for something different, looking for something to fill a void in your understanding of how big returns are actually made year after year, but didn't know where to turn for honest information, I hope my insights give you the confidence that ultimately helps you to make some big money.
Read the full book Trend Following!
What is trend following? Trend trading is reactive and systematic by nature. It does not forecast or predict markets or price levels. Prediction is impossible! Trend trading demands that you have strong self-discipline to follow precise rules (no guessing or wild emotions). It involves a risk management system that uses current market price, the equity level in your account and current market volatility. Trend traders use an initial risk rule that determines your position size at the time of entry. This means you know exactly how much to buy or sell based on how much money you have. Changes in price may lead to a gradual reduction or increase of your initial trade. On the other hand, adverse price movements may lead to an exit for your entire trade. Historically, A trend trader's average profit per trade is significantly higher than the average loss per trade.
Trend trading is not a Holy Grail. It is not some passing fad or hyped-up secret black box either. Beyond the mere rules, the human element is core to the strategy. It takes discipline and emotional control to stick with trend trading through the inevitable market ups and downs. Keep in mind though, Trend Followers expect ups and downs. They are planned for in advance. What must all trend followers consider?
Price: One of the first rules of trend following is that price is the main concern. If a market is at 60 and goes to 58, 57, 53 - the market is in a down trend. Despite what every news show might predict, if the trend is down, stay with the trend. A trader need only be concerned with what the market is doing, not what the market might do. The price tells you what the market is doing. Think about Bear Stearns, Lehman Brothers, WaMu, IndyMac, AIG, Fannie Mae, Goldman Sachs - didn't their down trends tell you all you needed to know? Did you fall for the nonsense that they would all bounce back?
Money Management: The most critical factor of trend following is not the timing of the trade or the indicator, but rather the determination of how much to trade over the course of the trend.
Risk Control: Trend following is grounded in a system of risk control and money management. The math is straightforward and easy to learn. During periods of higher market volatility, your trading size is reduced. During losing periods, positions are reduced and trade size is cut back. The main objective is to preserve capital until more favorable price trends reappear. Cutting losses is the way to stay in the game.
Rules Rule: Trend following should be systematic. Price and time are pivotal at all times. Trend Following is not based on an analysis of fundamental supply or demand factors. Trend Following does NOT involve seasonals, point and figure, Market Profile, triangles or day trading.
Trend Following answers these critical questions:
- How and when to enter the market.
- How many contracts or shares to trade at any time.
- How much money to risk on each trade.
- How to exit the trade if it becomes unprofitable.
- How to exit the trade if it becomes profitable.
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Conclusions
If you want in-and-out day trading, we can't help. Good trend following systems average five or six trades per market per year. Good trend following systems ride big winners and cut short small losses. What do you need to get started?
- An active mind, willingness to learn and passion to win.
- No knowledge of what an Italian bond is worth or what companies comprise the S&P or FTSE index. The key to trend trading is the price on the chart.
- Discipline and common sense to do the right thing per all rules.
- About an hour each day at the end of the day to check trades.
- A PC and telephone line (or internet connection).
Trading is a zero-sum game. For every winner, there is a loser. What's the difference between winners and losers? Smarts and strategy. For every loser in the NASDAQ implosion or the real estate/credit meltdown there was a winner. Does this mean that there are traders with neither strategy nor smarts actively losing, effectively shifting their funds to the winners, armed with strategy and smarts? Yes, absolutely.
